RBI Bans Foreclosure Fees on Floating Rate Loans to MSEs

• 04 Jul 2025
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The Reserve Bank of India (RBI) has forbidden banks as well as non-banking financial companies (NBFCs) from charging prepayment penalties on floating rate loans to businesses regarded as micro and small enterprises (MSEs). This new rule applies to all loans sanctioned or renewed on or after 1 January 2026. 

The new rule has been issued under Reserve Bank of India (Pre-payment Charges on Loans) Directions 2025. It comes after a supervisory assessment revealed that different lenders were following distinct practices. According to the assessment, a number of institutions were imposing inconsistent prepayment fees and, in certain situations, they were also putting restrictive conditions in loan agreements to deter MSE borrowers from moving to other lenders with better terms.

The RBI emphasized the significance of easy and affordable financing for MSEs and pointed out such provisions frequently resulted in complaints and disagreements from MSE borrowers, especially when they wanted to refinance their loans at lower interest rates. 

No prepayment charges will be permitted on floating rate loans to MSEs or individuals borrowing for business reasons, as per the new RBI rule. This condition applies regardless of whether the loan is prepaid in part or full, and irrespective of funding means used for making the prepayment. From the very first day of loan, the exemption will apply and will have no lock-in period. 

With that being said, certain categories of lenders are exempted from this requirement, including small finance banks, state and central co-operative banks, regional rural banks and middle regulatory layer NBFCs, which are also banned from levying prepayment penalties on loans up to Rs. 50 lakh. For such entities, the framework will remain the same. 

As far as crash credit and overdraft facilities are concerned, the Central Bank has made it clear that no prepayment penalty will be applicable as long as the borrower conveys to the lender their intention not to renew the facility within the agreed period and makes sure it is closed by the deadline. 

The central bank has told the lenders to clearly disclose applicable prepayment terms and conditions wherever applicable, such as in the sanction letter, loan agreement and key facts statements, to boost transparency. Lenders cannot reintroduce any previously waived-off fees. Additionally, retrospective charges are not permitted. 

Under the previous rules, retail borrowers were already exempt from prepayment charges. Now, with the new directive, RBI aims to extend similar benefits to small businesses that are often met with stricter credit conditions and limited ability to negotiate with Banks/NBFCs regarding the terms of loans. 

A draft circular that was issued in February this year led to this much-needed decision. The Reserve Bank of India (Pre-payment Charges on Loans) Directions 2025 aim to standardize customer-facing terms and reduce credit friction in the banking industry. 

Source: India Today